This time is different eight centuries of financial folly carmen m reinhart

C ONTENTSLIST OF TABLES LIST OF FIGURES LIST OF BOXES PREFACE ACKNOWLEDGMENTS PREAMBLE: SOME INITIAL INTUITIONS ON FINANCIAL FRAGILITY AND THE FICKLE NATURE OF CONFIDENCE PART I Financia

THIS TIME IS

DIFFERENT

THIS TIME IS DIFFERENT

Eight Centuries

of Financial Folly

CARMEN M REINHART KENNETH S ROGOFF

Copyright © 2009 by Princeton University PressPublished by Princeton University Press, 41 William Street,

Princeton, New Jersey 08540

In the United Kingdom: Princeton University Press, 6 Oxford Street,

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Thirteenth printing, and first paperback printing, 2011

Paperback ISBN 978-0-691-15264-6The Library of Congress has cataloged the cloth edition of this book as follows

Reinhart, Carmen M

This time is different : eight centuries of financial folly/

Carmen M Reinhart, Kenneth S Rogoff

p cm

Includes bibliographical references and index

ISBN 978-0-691-14216-6 (hardcover : alk paper)

1 Financial crises—Case studies 2 Fiscal policy—

Case studies 3 Business cycles—Case studies

I Rogoff, Kenneth S II Title

HB3722.R45 2009338.5′42—dc222009022616British Library Cataloging-in-Publication Data is available

This book has been composed in Goudy textwith Trade Gothic and Century italic byPrinceton Editorial Associates, Inc., Scottsdale, Arizona

Printed on acid-free paper ∞Printed in the United States of America

13 15 17 19 20 18 16 14

To William Reinhart, Juliana Rogoff, and Gabriel Rogoff

C ONTENTS

LIST OF TABLES LIST OF FIGURES LIST OF BOXES PREFACE ACKNOWLEDGMENTS PREAMBLE: SOME INITIAL INTUITIONS

ON FINANCIAL FRAGILITY AND THE FICKLE

NATURE OF CONFIDENCE

PART I

Financial Crises: An Operational Primer

1Varieties of Crises and Their Dates

Crises Defined by Quantitative Thresholds:Inflation, Currency Crashes, and DebasementCrises Defined by Events: Banking Crisesand External and Domestic Default

Other Key Concepts

2Debt Intolerance: The Genesis of Serial Default

Debt ThresholdsMeasuring VulnerabilityClubs and RegionsReflections on Debt Intolerance

3

A Global Database on Financial Crises

with a Long-Term ViewPrices, Exchange Rates, Currency Debasement,

and Real GDP

Government Finances and National Accounts

Public Debt and Its Composition

Global VariablesCountry Coverage

Odious DebtDomestic Public DebtConclusions

5Cycles of Sovereign Default on External Debt

Recurring PatternsDefault and Banking CrisesDefault and InflationGlobal Factors and Cycles of Global External Default

The Duration of Default Episodes

6External Default through HistoryThe Early History of Serial Default:

Emerging Europe, 1300–1799Capital Inflows and Default: An “Old World” StoryExternal Sovereign Default after 1800: A Global Picture

PART III

The Forgotten History of Domestic Debt and Default

7

The Stylized Facts of Domestic Debt and Default

Domestic and External DebtMaturity, Rates of Return, and Currency Composition

Episodes of Domestic DefaultSome Caveats Regarding Domestic Debt

8Domestic Debt: The Missing Link Explaining

External Default and High InflationUnderstanding the Debt Intolerance Puzzle

Domestic Debt on the Eve and in theAftermath of External DefaultThe Literature on Inflation and the “Inflation Tax”

Defining the Tax Base: Domestic Debt or the Monetary Base?

The “Temptation to Inflate” Revisited

9Domestic and External Default:

Which Is Worse? Who Is Senior?

Real GDP in the Run-up to and the Aftermath of Debt DefaultsInflation in the Run-up to and the Aftermath of Debt Defaults

The Incidence of Default on Debts Owed to

External and Domestic CreditorsSummary and Discussion of Selected Issues

PART IV

Banking Crises, Inflation, and Currency Crashes

10Banking Crises

A Preamble on the Theory of Banking Crises

Banking Crises: An Equal-Opportunity Menace

Banking Crises, Capital Mobility, and Financial LiberalizationCapital Flow Bonanzas, Credit Cycles, and Asset PricesOvercapacity Bubbles in the Financial Industry?

The Fiscal Legacy of Financial Crises Revisited

Living with the Wreckage: Some Observations

11Default through Debasement:

An “Old World Favorite”

12Inflation and Modern Currency Crashes

An Early History of Inflation Crises

Modern Inflation Crises: Regional Comparisons

Currency CrashesThe Aftermath of High Inflation and Currency Collapses

Undoing Domestic Dollarization

PART V

The U.S Subprime Meltdown and the

Second Great Contraction

13The U.S Subprime Crisis: An International

and Historical Comparison

A Global Historical View of the Subprime

Crisis and Its AftermathThe This-Time-Is-Different Syndrome and the

Run-up to the Subprime CrisisRisks Posed by Sustained U.S Borrowing from theRest of the World: The Debate before the CrisisThe Episodes of Postwar Bank-Centered Financial Crisis

A Comparison of the Subprime Crisis with

Past Crises in Advanced Economies

Summary

14The Aftermath of Financial CrisesHistorical Episodes RevisitedThe Downturn after a Crisis: Depth and Duration

The Fiscal Legacy of Crises

Sovereign RiskComparisons with Experiences from the

First Great Contraction in the 1930s

Concluding Remarks

15The International Dimensions of the Subprime Crisis:The Results of Contagion or Common Fundamentals?

Concepts of ContagionSelected Earlier EpisodesCommon Fundamentals and the Second Great Contraction

Are More Spillovers Under Way?

16Composite Measures of Financial Turmoil

Developing a Composite Index of Crises: The BCDI Index

Defining a Global Financial CrisisThe Sequencing of Crises: A Prototype

Summary

PART VI

What Have We Learned?

17Reflections on Early Warnings, Graduation,

Policy Responses, and the Foibles of Human Nature

On Early Warnings of CrisesThe Role of International Institutions

GraduationSome Observations on Policy Responses

The Latest Version of the This-Time-Is-Different Syndrome

DATA APPENDIXES

A.1 Macroeconomic Time Series

A.2 Public DebtA.3 Dates of Banking CrisesA.4 Historical Summaries of Banking Crises

NOTES REFERENCES

NAME INDEX SUBJECT INDEX

T ABLES

1.1 Defining crises: A summary of quantitative thresholds

1.2 Defining crises by events: A summary

2.1 External debt at the time of default: Middle-income countries, 1970–2008

2.2 External debt at the time of default: Frequency distribution, 1970–2008

2.3 Risk and debt: Panel pairwise correlations, 1979–2007

3.1 Countries’ share of world GDP, 1913 and 1990

6.1 The early external defaults: Europe, 1300–1799

6.2 External default and rescheduling: Africa, Europe, and Latin America, nineteenth century6.3 Default and rescheduling: Africa and Asia, twentieth century to 2008

6.4 Default and rescheduling: Europe and Latin America, twentieth century to 2008

6.5 The cumulative tally of default and rescheduling: Africa and Asia, year of independence to

2008

6.6 The cumulative tally of default and rescheduling: Europe, Latin America, North America,

and Oceania, year of independence to 2008

7.1 Interest rates on domestic and external debt, 1928–1946

7.2 Selected episodes of domestic debt default or restructuring, 1740–1921

7.3 Selected episodes of domestic debt default or restructuring, late 1920s–1950s

7.4 Selected episodes of domestic debt default or restructuring, 1970–2008

8.1 Debt ratios at the time of default: Selected episodes

8.2 Inflation and domestic public debt: Selected episodes, 1917–1994

9.1 Output and inflation around and during debt crises

9.2 Who gets expropriated, residents or foreigners? Preliminary tests for the equality of two

proportions (binomial distribution), 1800–2006

10.1 Debt and banking crises: Africa and Asia, year of independence to 2008

10.2 Debt and banking crises: Europe, Latin America, North America, and Oceania, year of

independence to 2008

10.3 Frequency of banking crises: Africa and Asia, to 2008

10.4 Frequency of banking crises: Europe, Latin America, North America, and Oceania, to 200810.5 Summary of the incidence and frequency of banking crises, 1800 (or independence) to 200810.6 Summary of the incidence and frequency of banking crises, 1945 (or independence) to 2008

10.7 The effect of a capital flow bonanza on the probability of a banking crisis in a sixty-six

country sample, 1960–2007

10.8 Cycles of real housing prices and banking crises

10.9 Creative accounting? Bailout costs of banking crises

11.1 Expropriation through currency debasement: Europe, 1258–1799

11.2 Expropriation through currency debasement: Europe, nineteenth century

12.1 “Default” through inflation: Asia, Europe, and the “New World,” 1500–1799

12.2 “Default” through inflation: Africa and Asia, 1800–2008

12.3 “Default” through inflation: Europe, Latin America, North America, and Oceania, 1800–200813.1 Post–World War II bank-centered financial crises in advanced economies

14.1 Fiscal deficits (central government balance) as a percentage of GDP

15.1 Global banking crises, 1890–2008: Contagion or common fundamentals?

16.1 Indexes of total building activity in selected countries

16.2 Unemployment rates for selected countries, 1929–1932

17.1 Early warning indicators of banking and currency crises: A summary

17.2 Institutional Investor ratings of sixty-six countries: Upgrade or demotion, 1979–2008

A.1.1 Prices: Consumer or cost-of-living indexes

A.1.2 Modern nominal exchange rates

A.1.3 Early silver-based exchange rates

A.1.4 The silver content of currencies

A.1.5 Index of nominal and real gross national product and output

A.1.6 Gross national product

A.1.7 Central government expenditures and revenues

A.1.8 Total exports and imports

A.1.9 Global indicators and financial centers

A.1.10 Real house prices

A.1.11 Stock market indexes (equity prices)

A.2.1 Public debentures: External government bond issuesA.2.2 Total (domestic plus external) public debt

A.2.3 External public debt

A.2.4 Domestic public debt

A.3.1 Banking crisis dates and capital mobility, 1800–2008A.4.1 Banking crises: Historical summaries, 1800–2008

F IGURES

P.1 Sovereign external debt, 1800–2008: Percentage of countries in external default or

restructuring weighted by their share of world income

2.1 Ratios of external debt to GNP: Defaulters and nondefaulters, 1970–2008

2.2 Definition of debtors’ clubs and external debt intolerance regions

5.1 Sovereign external debt: Countries in external default or restructuring, unweighted, 1800–

5.4 Inflation crises and external default, 1900–2007

5.5 Commodity prices and new external defaults, 1800–2008

5.6 Net capital flows from financial centers and external default, 1818–1939

5.7 Duration of external default episodes, 1800–2008

6.1 Spain: Defaults and loans to the Crown, 1601–1679

7.1 Domestic public debt as a share of total debt: All countries, 1900–2007

7.2 Domestic public debt as a share of total debt: Advanced economies, 1900–2007

7.3 Domestic public debt as a share of total debt: Emerging market economies, 1900–2007

7.4 Share of domestic debt that is long term: All countries and Latin America, 1914–1959

7.5 Sovereign domestic debt: Percent of countries in default or restructuring, 1900–2008

8.1 Ratios of public debt to revenue during external default: Eighty-nine episodes, 1827–2003

8.2 Ratios of public debt to revenue during external default: Frequency of occurrence, 1827–

9.1 Real GDP before, during, and after domestic and external debt crises, 1800–2008

9.2 Domestic and external debt crises and GDP, three years before crisis and year of crisis,

1800–2008

9.3 Consumer prices before, during, and after domestic and external debt crises, 1800–2008

9.4 Domestic and external debt crises and inflation, three years before crisis and year of crisis,

10.1 Capital mobility and the incidence of banking crises: All countries, 1800–2008

10.2 Real equity prices and banking crises: Forty episodes in emerging markets, 1920–2007

10.3 The number of banks in the United States, 1900–1945

10.4 Real GDP growth per capita (PPP basis) and banking crises: Advanced economies

10.5 Real GDP growth per capita (PPP basis) and banking crises: Emerging market economies

(112 episodes)

10.6 Real central government revenue growth and banking crises: All countries, 1800–1944

10.7 Real central government revenue growth and banking crises: All countries, 1945–2007

10.8 Real central government revenue growth and banking crises: Advanced economies, 1815–

12.1 The median inflation rate: Five-year moving average for all countries, 1500–2007

12.2 The incidence of annual inflation above 20 percent: Africa, Asia, Europe, and Latin America,

12.5 The persistence of dollarization

12.6 The de-dollarization of bank deposits: Israel, Poland, Mexico, and Pakistan, 1980–2002

13.1 The proportion of countries with banking crises, 1900–2008, weighted by their share of

world income

13.2 Real housing prices: United States, 1891–2008

13.3 Real housing prices and postwar banking crises: Advanced economies

13.4 Real equity prices and postwar banking crises: Advanced economies

13.5 Ratio of current account balance to GDP on the eve of postwar banking crises: Advanced

economies

13.6 Growth in real per capita GDP (PPP basis) and postwar banking crises: Advanced

economies

13.7 Real central government debt and postwar banking crises: Advanced economies

14.1 Cycles of past and ongoing real house prices and banking crises

14.2 Cycles of past and ongoing real equity prices and banking crises

14.3 Cycles of past unemployment and banking crises

14.4 Cycles of past real per capita GDP and banking crises

14.5 The cumulative increase in real public debt in the three years following past banking crises14.6 Cycles of Institutional Investor sovereign ratings and past banking crises

14.7 The duration of major financial crises: Fourteen Great Depression episodes versus fourteen

post–World War II episodes (duration of the fall in output per capita)

14.8

The duration of major financial crises: Fourteen Great Depression episodes versus fourteenpost–World War II episodes (number of years for output per capita to return to its precrisislevel)

14.9 The cumulative increase in real public debt three and six years following the onset of the

Great Depression in 1929: Selected countries

15.1 Percentage change in real housing prices, 2002–2006

16.1 The proportion of countries with systemic banking crises (weighted by their share of world

income) and U.S corporate speculative-grade default rates, 1919–2008

16.2 Varieties of crises: World aggregate, 1900–2008

16.3 Varieties of crises: Advanced economies aggregate, 1900–2008

16.4 Varieties of crises: Africa, 1900–2008

16.5 Varieties of crises: All countries and Asia, 1800–2008

16.6 Varieties of crises: All countries and Latin America, 1800–2008

16.7 Global stock markets during global crises: The composite real stock price index (end of

period)

16.8 Real per capita GDP during global financial crises: Multicountry aggregates (PPP weighted)16.9 The contracting spiral of world trade month by month, January 1929–June 1933

16.10 World export growth, 1928–2009

16.11 The collapse of exports, 1929–1932

16.12 The sequencing of crises: A prototype

17.1 Change in Institutional Investor sovereign credit ratings of sixty-six countries, 1979–2008

B OXES

1.1 Debt glossary

1.2 The this-time-is-different syndrome on the eve of the Crash of 1929

5.1 The development of international sovereign debt markets in England and Spain5.2 External default penalized: The extraordinary case of Newfoundland, 1928–19335.3 External default penalized? The case of the missing “Brady bunch”

6.1 France’s graduation after eight external defaults, 1558–1788

6.2 Latin America’s early days in international capital markets, 1822–1825

7.1 Foreign currency–linked domestic debt: Thai tesobonos?

16.1 Global financial crises: A working definition

This book provides a quantitative history of financial crises in their various guises Our basicmessage is simple: We have been here before No matter how different the latest financial frenzy orcrisis always appears, there are usually remarkable similarities with past experience from othercountries and from history Recognizing these analogies and precedents is an essential step towardimproving our global financial system, both to reduce the risk of future crisis and to better handlecatastrophes when they happen

If there is one common theme to the vast range of crises we consider in this book, it is thatexcessive debt accumulation, whether it be by the government, banks, corporations, or consumers,often poses greater systemic risks than it seems during a boom Infusions of cash can make agovernment look like it is providing greater growth to its economy than it really is Private sectorborrowing binges can inflate housing and stock prices far beyond their long-run sustainable levels,and make banks seem more stable and profitable than they really are Such large-scale debt buildupspose risks because they make an economy vulnerable to crises of confidence, particularly when debt

is short term and needs to be constantly refinanced Debt-fueled booms all too often provide falseaffirmation of a government’s policies, a financial institution’s ability to make outsized profits, or acountry’s standard of living Most of these booms end badly Of course, debt instruments are crucial

to all economies, ancient and modern, but balancing the risk and opportunities of debt is always achallenge, a challenge policy makers, investors, and ordinary citizens must never forget

In this book we study a number of different types of financial crises They include sovereigndefaults, which occur when a government fails to meet payments on its external or domestic debtobligations or both Then there are banking crises such as those the world has experienced in spades

in the late 2000s In a typical major banking crisis, a nation finds that a significant part of its bankingsector has become insolvent after heavy investment losses, banking panics, or both Another importantclass of crises consists of exchange rate crises such as those that plagued Asia, Europe, and LatinAmerica in the 1990s In the quintessential exchange rate crisis, the value of a country’s currency fallsprecipitously, often despite a government “guarantee” that it will not allow this to happen under anycircumstances We also consider crises marked by bouts of very high inflation Needless to say,unexpected increases in inflation are the de facto equivalent of outright default, for inflation allowsall debtors (including the government) to repay their debts in currency that has much less purchasingpower than it did when the loans were made In much of the book we will explore these crisesseparately But crises often occur in clusters In the penultimate text chapter of the book we will look

at situations—such as the Great Depression of the 1930s and the latest worldwide financial crisis—

in which crises occur in bunches and on a global scale

Of course, financial crises are nothing new They have been around since the development ofmoney and financial markets Many of the earliest crises were driven by currency debasements thatoccurred when the monarch of a country reduced the gold or silver content of the coin of the realm tofinance budget shortfalls often prompted by wars Technological advances have long since eliminated

a government’s need to clip coins to fill a budget deficit But financial crises have continued to thrivethrough the ages, and they plague countries to this day

Most of our focus in this book is on two particular forms of crises that are particularly relevanttoday: sovereign debt crises and banking crises Both have histories that span centuries and cut acrossregions Sovereign debt crises were once commonplace among the now advanced economies thatappear to have “graduated” from periodic bouts of government insolvency In emerging markets,however, recurring (or serial) default remains a chronic and serious disease Banking crises, incontrast, remain a recurring problem everywhere They are an equal-opportunity menace, affectingrich and poor countries alike Our banking crisis investigation takes us on a tour from bank runs andbank failures in Europe during the Napoleonic Wars to the recent global financial crises that beganwith the U.S subprime crisis of 2007.

Our aim here is to be expansive, systematic, and quantitative: our empirical analysis coverssixty-six countries over nearly eight centuries Many important books have been written about thehistory of international financial crises,1 perhaps the most famous of which is Kindleberger’s 1989

book Manias, Panics and Crashes.2 By and large, however, these earlier works take an essentiallynarrative approach, fortified by relatively sparse data

Here, by contrast, we build our analysis around data culled from a massive database thatencompasses the entire world and goes back as far as twelfth-century China and medieval Europe.The core “life” of this book is contained in the (largely) simple tables and figures in which these dataare presented rather than in narratives of personalities, politics, and negotiations We trust that ourvisual quantitative history of financial crises is no less compelling than the earlier narrativeapproach, and we hope that it may open new vistas for policy analysis and research

Above all, our emphasis is on looking at long spans of history to catch sight of “rare” events thatare all too often forgotten, although they turn out to be far more common and similar than people seem

to think Indeed, analysts, policy makers, and even academic economists have an unfortunate tendency

to view recent experience through the narrow window opened by standard data sets, typically based

on a narrow range of experience in terms of countries and time periods A large fraction of theacademic and policy literature on debt and default draws conclusions based on data collected since

1980, in no small part because such data are the most readily accessible This approach would befine except for the fact that financial crises have much longer cycles, and a data set that coverstwenty-five years simply cannot give one an adequate perspective on the risks of alternative policiesand investments An event that was rare in that twenty-five-year span may not be all that rare whenplaced in a longer historical context After all, a researcher stands only a one-in-four chance ofobserving a “hundred-year flood” in twenty-five years’ worth of data To even begin to think aboutsuch events, one needs to compile data for several centuries Of course, that is precisely our aim here

In addition, standard data sets are greatly limited in several other important respects, especially

in regard to their coverage of the types of government debt In fact, as we shall see, historical data ondomestically issued government debt is remarkably difficult to obtain for most countries, which haveoften been little more transparent than modern-day banks with their off–balance sheet transactions andother accounting shenanigans

The foundations of our analysis are built on a comprehensive new database for studyinginternational debt and banking crises, inflation, and currency crashes and debasements The data comefrom Africa, Asia, Europe, Latin America, North America, and Oceania (data from sixty-six countries

in all, as previously noted, plus selected data for a number of other countries) The range of variablesencompasses, among many other dimensions, external and domestic debt, trade, national income,inflation, exchange rates, interest rates, and commodity prices The data coverage goes back more

than eight hundred years, to the date of independence for most countries and well into the colonialperiod for several Of course, we recognize that the exercises and illustrations that we provide herecan only scratch the surface of what a data set of this scope and scale can potentially unveil.

Fortunately, conveying the details of the data is not essential to understanding the main message

of this book: we have been here before The instruments of financial gain and loss have varied overthe ages, as have the types of institutions that have expanded mightily only to fail massively Butfinancial crises follow a rhythm of boom and bust through the ages Countries, institutions, andfinancial instruments may change across time, but human nature does not As we will discuss in thefinal chapters of this book, the financial crisis of the late 2000s that originated in the United Statesand spread across the globe—which we refer to as the Second Great Contraction—is only the latestmanifestation of this pattern

We take up the latest crisis in the final four chapters before the conclusion, in which we reviewwhat we have learned; the reader should find the material in chapters 13–16 relativelystraightforward and self-contained (Indeed, readers interested mainly in lessons of history for thelatest crisis are encouraged to jump directly to this material in a first reading.) We show that in therun-up to the subprime crisis, standard indicators for the United States, such as asset price inflation,rising leverage, large sustained current account deficits, and a slowing trajectory of economic growth,exhibited virtually all the signs of a country on the verge of a financial crisis—indeed, a severe one.This view of the way into a crisis is sobering; we show that the way out can be quite perilous aswell The aftermath of systemic banking crises involves a protracted and pronounced contraction ineconomic activity and puts significant strains on government resources

The first part of the book gives precise definitions of concepts describing crises and discussesthe data underlying the book In the construction of our data set we have built heavily on the work ofearlier scholars However, our data set also includes a considerable amount of new material fromdiverse primary and secondary sources In addition to providing a systematic dating of external debtand exchange rate crises, the appendixes to this book catalog dates for domestic inflation and bankingcrises The dating of sovereign defaults on domestic (mostly local-currency) debt is one of the morenovel features that rounds out our study of financial crises

The payoff to this scrutiny comes in the remaining parts of the book, which apply these concepts

to our expanded global data set Part II turns our attention to government debt, chronicling hundreds ofepisodes of default by sovereign nations on their debt to external creditors These “debt crises” haveranged from those related to mid-fourteenth-century loans by Florentine financiers to England’sEdward III to German merchant bankers’ loans to Spain’s Hapsburg Monarchy to massive loans made

by (mostly) New York bankers to Latin America during the 1970s Although we find that during themodern era sovereign external default crises have been far more concentrated in emerging marketsthan banking crises have been, we nevertheless emphasize that even sovereign defaults on externaldebt have been an almost universal rite of passage for every country as it has matured from anemerging market economy to an advanced developed economy This process of economic, financial,social, and political development can take centuries

Indeed, in its early years as a nation-state, France defaulted on its external debt no fewer thaneight times (as we show in chapter 6)! Spain defaulted a mere six times prior to 1800, but, with sevendefaults in the nineteenth century, surpassed France for a total of thirteen episodes Thus, whentoday’s European powers were going through the emerging market phase of development, theyexperienced recurrent problems with external debt default, just as many emerging markets do today

From 1800 until well after World War II, Greece found itself virtually in continual default, andAustria’s record is in some ways even more stunning Although the development of internationalcapital markets was quite limited prior to 1800, we nevertheless catalog the numerous defaults ofFrance, Portugal, Prussia, Spain, and the early Italian city-states At the edge of Europe, Egypt,Russia, and Turkey have histories of chronic default as well.

One of the fascinating questions raised in our book is why a relatively small number of countries,such as Australia and New Zealand, Canada, Denmark, Thailand, and the United States, havemanaged to avoid defaults on central government debt to foreign creditors, whereas far morecountries have been characterized by serial default on their external debts

Asian and African financial crises are far less researched than those of Europe and LatinAmerica Indeed, the widespread belief that modern sovereign default is a phenomenon confined toLatin America and a few poorer European countries is heavily colored by the paucity of research onother regions As we shall see, precommunist China repeatedly defaulted on international debts, andmodern-day India and Indonesia both defaulted in the 1960s, long before the first postwar round ofLatin defaults Postcolonial Africa has a default record that looks as if it is set to outstrip that of anypreviously emerging market region Overall, we find that a systematic quantitative examination of thepostcolonial default records of Asia and Africa debunks the notion that most countries have avoidedthe perils of sovereign default

The near universality of default becomes abundantly clear in part II, where we begin to use thedata set to paint the history of default and financial crises in broad strokes using tables and figures.One point that certainly jumps out from the analysis is that the fairly recent (2003–2008) quiet spell inwhich governments have generally honored their debt obligations is far from the norm

The history of domestic public debt (i.e., internally issued government debt) in emerging markets,

in particular, has largely been ignored by contemporary scholars and policy makers (even by officialdata providers such as the International Monetary Fund), who seemed to view its emergence at thebeginning of the twenty-first century as a stunning new phenomenon Yet, as we will show in part III,domestic public debt in emerging markets has been extremely significant during many periods and infact potentially helps resolve a host of puzzles pertaining to episodes of high inflation and default Weview the difficulties one experiences in finding data on government debt as just one facet of thegeneral low level of transparency with which most governments maintain their books Think of theimplicit guarantees given to the massive mortgage lenders that ultimately added trillions to theeffective size of the U.S national debt in 2008, the trillions of dollars in off–balance sheettransactions engaged in by the Federal Reserve, and the implicit guarantees involved in taking badassets off bank balance sheets, not to mention unfunded pension and medical liabilities Lack oftransparency is endemic in government debt, but the difficulty of finding basic historical data oncentral government debt is almost comical

Part III also offers a first attempt to catalog episodes of overt default on and rescheduling ofdomestic public debt across more than a century (Because so much of the history of domestic debthas largely been forgotten by scholars, not surprisingly, so too has its history of default.) Thisphenomenon appears to be somewhat rarer than external default but is far too common to justify theextreme assumption that governments always honor the nominal face value of domestic debt, anassumption that dominates the economics literature When overt default on domestic debt does occur,

it appears to occur in situations of greater duress than those that lead to pure external default—interms of both an implosion of output and a marked escalation of inflation

Part IV broadens our discussion to include crises related to banking, currency, and inflation.Until very recently, the study of banking crises has typically focused either on earlier historicalexperiences in advanced countries, mainly the banking panics before World War II, or on modern-dayexperiences in emerging markets This dichotomy has perhaps been shaped by the belief that foradvanced economies, destabilizing, systemic, multicountry financial crises are a relic of the past Ofcourse, the recent global financial crisis emanating out of the United States and Europe has dashedthis misconception, albeit at great social cost.

The fact is that banking crises have long plagued rich and poor countries alike We reach thisconclusion after examining banking crises ranging from Denmark’s financial panic during theNapoleonic Wars to the recent first global financial crisis of the twenty-first century The incidence

of banking crises proves to be remarkably similar in the high- and the middle- to low-incomecountries Banking crises almost invariably lead to sharp declines in tax revenues as well assignificant increases in government spending (a share of which is presumably dissipative) Onaverage, government debt rises by 86 percent during the three years following a banking crisis Theseindirect fiscal consequences are thus an order of magnitude larger than the usual costs of bankbailouts

Episodes of treacherously high inflation are another recurrent theme No emerging market country

in history has managed to escape bouts of high inflation Indeed, there is a very strong parallelbetween our proposition that few countries have avoided serial default on external debt and theproposition that few countries have avoided serial bouts of high inflation Even the United States hashad a checkered history, including in 1779, when the inflation rate approached 200 percent Early onacross the world, as already noted, the main device for defaulting on government obligations was that

of debasing the content of the coinage Modern currency presses are just a technologically advancedand more efficient approach to achieving the same end As a consequence, a clear inflationary biasthroughout history emerges Starting in the twentieth century, inflation spiked radically higher Sincethen, inflation crises have stepped up to a higher plateau Unsurprisingly, then, the more modernperiod also has seen a higher incidence of exchange rate crashes and larger median changes incurrency values Perhaps more surprising, and made visible only by a broader historical context, arethe early episodes of pronounced exchange rate instability, notably during the Napoleonic Wars

Just as financial crises have common macroeconomic antecedents in asset prices, economicactivity, external indicators, and so on, so do common patterns appear in the sequencing (temporalorder) in which crises unfold, the final subject of part IV

The concluding chapter offers some reflections on crises, policy, and pathways for academicstudy What is certainly clear is that again and again, countries, banks, individuals, and firms take onexcessive debt in good times without enough awareness of the risks that will follow when theinevitable recession hits Many players in the global financial system often dig a debt hole far largerthan they can reasonably expect to escape from, most famously the United States and its financialsystem in the late 2000s Government and government-guaranteed debt (which, due to depositinsurance, often implicitly includes bank debt) is certainly the most problematic, for it can accumulatemassively and for long periods without being put in check by markets, especially where regulationprevents them from effectively doing so Although private debt certainly plays a key role in manycrises, government debt is far more often the unifying problem across the wide range of financialcrises we examine As we stated earlier, the fact that basic data on domestic debt are so opaque anddifficult to obtain is proof that governments will go to great lengths to hide their books when things

are going wrong, just as financial institutions have done in the contemporary financial crisis We see

a major role for international policy-making organizations, such as the International Monetary Fund,

in providing government debt accounts that are more transparent than those available today

Figure P.1 Sovereign external debt, 1800–2008: Percentage of countries in external default or restructuring weighted by their share of

world income.

Our immersion in the details of crises that have arisen over the past eight centuries and in data onthem has led us to conclude that the most commonly repeated and most expensive investment adviceever given in the boom just before a financial crisis stems from the perception that “this time isdifferent.” That advice, that the old rules of valuation no longer apply, is usually followed up withvigor Financial professionals and, all too often, government leaders explain that we are doing thingsbetter than before, we are smarter, and we have learned from past mistakes Each time, societyconvinces itself that the current boom, unlike the many booms that preceded catastrophic collapses inthe past, is built on sound fundamentals, structural reforms, technological innovation, and goodpolicy

Given the sweeping data on which this book has been built, it is simply not possible to providetextural context to all the hundreds of episodes the data encompass Nevertheless, the tables andfigures speak very powerfully for themselves of the phenomenal recurrent nature of the problem Take

figure P.1, which shows the percentage of countries worldwide, weighted by GDP, that have been in

a state of default on their external debt at any time

The short period of the 2000s, represented by the right-hand tail of the chart, looks sufficientlybenign But was it right for so many policy makers to declare by 2005 that the problem of sovereigndefault on external debt had gone into deep remission? Unfortunately, even before the ink is dry onthis book, the answer will be clear enough We hope that the weight of evidence in this book willgive future policy makers and investors a bit more pause before next they declare, “This time isdifferent.” It almost never is

A CKNOWLEDGMENTS

A book so long in the making generates many debts of gratitude Among those who helped is VincentReinhart, who consulted on the economic and statistical content and edited and re-edited all thechapters He also provided the anecdote that led to the book’s title Vincent worked for the FederalReserve for almost a quarter century Back around the time of the collapse of the hedge fund Long-Term Capital Management in 1998, which seemed like a major crisis then but seems less so givenrecent events, he attended a meeting of the board of governors with market practitioners A traderwith an uncharacteristically long memory explained, “More money has been lost because of fourwords than at the point of a gun Those words are ‘This time is different.’”

A special debt of gratitude is owed to Jane Trahan for her extremely helpful and thorough editing

of the manuscript, and to our editor at Princeton University Press, Seth Ditchik, for his suggestionsand editorial guidance throughout this process Ethan Ilzetzki, Fernando Im, Vania Stavrakeva,Katherine Waldock, Chenzi Xu, and Jan Zilinsky provided excellent research assistance We are alsograteful to Peter Strupp and his colleagues at Princeton Editorial Associates for skillfully negotiatingall the technical details of producing this volume

PREAMBLE: SOME INITIAL INTUITIONS

FICKLE NATURE OF CONFIDENCE

This book summarizes the long history of financial crises in their many guises across many countries.Before heading into the deep waters of experience, this chapter will attempt to sketch an economicframework to help the reader understand why financial crises tend to be both unpredictable anddamaging As the book unfolds, we will take other opportunities to guide interested readers throughthe related academic literature when it is absolutely critical to our story Rest assured that these areonly short detours, and those unconcerned with economic theory as an engine of discovery can bypassthese byways

As we shall argue, economic theory proposes plausible reasons that financial markets,particularly ones reliant on leverage (which means that they have thin capital compared to the amount

of assets at stake), can be quite fragile and subject to crises of confidence.1 Unfortunately, theorygives little guidance on the exact timing or duration of these crises, which is why we focus so onexperience

Perhaps more than anything else, failure to recognize the precariousness and fickleness ofconfidence—especially in cases in which large short-term debts need to be rolled over continuously

—is the key factor that gives rise to the this-time-is-different syndrome Highly indebted governments,

banks, or corporations can seem to be merrily rolling along for an extended period, when bang!—

confidence collapses, lenders disappear, and a crisis hits

The simplest and most familiar example is bank runs (which we take up in more detail in thechapter on banking crises) We talk about banks for two reasons First, that is the route along whichthe academic literature developed Second, much of our historical data set applies to the borrowing

of banks and of governments (Other large and liquid participants in credit markets are relatively newentrants to the world of finance.) However, our examples are quite illustrative of a broaderphenomenon of financial fragility Many of the same general principles apply to these market actors,whether they be government-sponsored enterprises, investment banks, or money market mutual funds

Banks traditionally borrow at short term That is, they borrow in the form of deposits that can beredeemed on relatively short notice But the loans they make mostly have a far longer maturity and can

be difficult to convert into cash on short notice For example, a bank financing the expansion of alocal hardware store might be reasonably confident of repayment in the long run as the store expandsits business and revenues But early in the expansion, the bank may have no easy way to call in theloan The store owner simply has insufficient revenues, particularly if forced to make payments onprincipal as well as interest

A bank with a healthy deposit base and a large portfolio of illiquid loans may well have brightprospects over the long term However, if for some reason, depositors all try to withdraw their funds

at once—say, because of panic based on a false rumor that the bank has lost money gambling onexotic mortgages—trouble ensues Absent a way to sell its illiquid loan portfolio, the bank mightsimply not be able to pay off its panicked depositors Such was the fate of the banks in the classic

movies It’s a Wonderful Life and Mary Poppins Those movies were rooted in reality: many banks

have shared this fate, particularly when the government has not fully guaranteed bank deposits

The most famous recent example of a bank run is the run on the United Kingdom’s Northern Rockbank Panicked depositors, not satisfied with the British government’s partial insurance scheme,formed long queues in September 2007 The broadening panic eventually forced the Britishgovernment to take over the bank and more fully back its liabilities

Other borrowers, not just banks, can suffer from a crisis of confidence During the financialcrisis that started in the United States in 2007, huge financial giants in the “shadow banking” systemoutside regulated banks suffered similar problems Although they borrowed mainly from banks andother financial institutions, their vulnerability was the same As confidence in the investments theyhad made fell, lenders increasingly refused to roll over their short-term loans, and they were forced

to throw assets on the market at fire-sale prices Distressed sales drove prices down further, leading

to further losses and downward-spiraling confidence Eventually, the U.S government had to step in

to try to prop up the market; the drama is still unfolding, and the price tag for resolution continues tomount

Governments can be subject to the same dynamics of fickle expectations that can destabilizebanks This is particularly so when a government borrows from external lenders over whom it hasrelatively little influence Most government investments directly or indirectly involve the long-rungrowth potential of the country and its tax base, but these are highly illiquid assets Suppose, forexample, that a country has a public debt burden that seems manageable given its current tax revenues,growth projections, and market interest rates If the market becomes concerned that a populist fringecandidate is going to win the next election and raise spending so much that the debt will becomedifficult to manage, investors may suddenly balk at rolling over short-term debt at rates the countrycan manage A credit crisis unfolds

Although these kinds of scenarios are not everyday events, over the long course of history and thebroad range of countries we cover in this book, such financial crises occur all too frequently Whycannot big countries, or even the world as a whole, find a way to put a stop to crises of confidence, atleast premature ones? It is possible, but there is a rub Suppose a world government agency providedexpansive deposit insurance to protect every worthy borrower from panics Say there was a super-sized version of the International Monetary Fund (IMF), today’s main multilateral lender that aims tohelp emerging markets when they run into liquidity crises The problem is that if one providesinsurance to everyone everywhere, with no conditions, some players are going to misbehave If theIMF lent too much with too few conditions, the IMF itself would be bankrupt in short order, andfinancial crises would be unchecked Complete insurance against crises is neither feasible nordesirable (Exactly this conundrum will face the global financial community in the wake of the latestfinancial crisis, with the IMF’s lending resources having been increased fourfold in response to thecrisis while, at the same time, lending conditionality has been considerably relaxed.)

What does economic theory have to say about countries’ vulnerability to financial crises? Forconcreteness, let us focus for now on governments, the main source of the crises examined in thisbook Economic theory tells us that if a government is sufficiently frugal, it is not terribly vulnerable

to crises of confidence A government does not have to worry too much about debt crises if itconsistently runs fiscal surpluses (which happens when tax receipts exceed expenditures), maintainsrelatively low debt levels, mostly borrows at longer-term maturities (say ten years or more), anddoes not have too many hidden off–balance sheet guarantees

If, in contrast, a government runs large deficits year after year, concentrating its borrowing atshorter-term maturities (of say one year or less), it becomes vulnerable, perhaps even at debt-burdenlevels that seemingly should be quite manageable Of course, an ill-intentioned government could try

to reduce its vulnerability by attempting to issue large amounts of long-term debt But most likely,markets would quickly catch on and charge extremely high interest rates on any long-dated borrowing.Indeed, a principal reason that some governments choose to borrow at shorter maturities instead oflonger maturities is precisely so that they can benefit from lower interest rates as long as confidencelasts

Economic theory tells us that it is precisely the fickle nature of confidence, including itsdependence on the public’s expectation of future events, that makes it so difficult to predict the timing

of debt crises High debt levels lead, in many mathematical economics models, to “multipleequilibria” in which the debt level might be sustained—or might not be.2 Economists do not have aterribly good idea of what kinds of events shift confidence and of how to concretely assessconfidence vulnerability What one does see, again and again, in the history of financial crises is thatwhen an accident is waiting to happen, it eventually does When countries become too deeplyindebted, they are headed for trouble When debt-fueled asset price explosions seem too good to betrue, they probably are But the exact timing can be very difficult to guess, and a crisis that seemsimminent can sometimes take years to ignite Such was certainly the case of the United States in thelate 2000s As we show in chapter 13, all the red lights were blinking in the run-up to the crisis Butuntil the “accident,” many financial leaders in the United States—and indeed many academics—werestill arguing that “this time is different.”

We would like to note that our caution about excessive debt burdens and leverage forgovernments is different from the admonitions of the traditional public choice literature of Buchananand others.3 The traditional public finance literature warns about the shortsightedness of governments

in running fiscal deficits and their chronic failure to weigh the long-run burden that servicing debtwill force on their citizens In fact, excessive debt burdens often generate problems in the nearer term,precisely because investors may have doubts about the country’s will to finance the debt over thelonger term The fragility of debt can be every bit as great a problem as its long-term tax burden, attimes even greater

Similar fragility problems arise in other crisis contexts that we will consider in this book One ofthe lessons of the 1980s and 1990s is that countries maintaining fixed or “highly managed” exchangerate regimes are vulnerable to sudden crises of confidence Speculative attacks on fixed exchangerates can blow up overnight seemingly stable long-lived regimes During the period of the successfulfix, there is always plenty of this-time-is-different commentary But then, as in the case of Argentina

in December 2001, all the confidence can collapse in a puff of smoke There is a fundamental link todebt, however As Krugman famously showed, exchange rate crises often have their roots in agovernment’s unwillingness to adopt fiscal and monetary policies consistent with maintaining a fixedexchange rate.4 If speculators realize the government is eventually going to run out of the resourcesneeded to back the currency, they will all be looking to time their move out of the currency inanticipation of the eventual crash Public debts do not always have to be explicit; contingentgovernment guarantees have been at the crux of many a crisis

Certainly countries have ways of making themselves less vulnerable to crises of confidence short

of simply curtailing their borrowing and leverage Economic theory suggests that greater transparencyhelps As the reader shall see later on, governments tend to be anything but transparent when it comes

to borrowing And as the financial crisis of the late 2000s shows, private borrowers are often littlebetter unless government regulation forces them to be more transparent A country with stronger legaland regulatory institutions can certainly borrow more Indeed, many scholars consider Britain’sdevelopment of superior institutions for making debt repayment credible a key to its military anddevelopment successes in the eighteenth and nineteenth centuries.5 But even good institutions and asophisticated financial system can run into problems if faced with enough strains, as the United Stateshas learned so painfully in the most recent crisis.

Finally, there is the question of why financial crises tend to be so painful, a topic we take upmainly in the introduction to chapter 10 on banking crises In brief, most economies, even relativelypoor ones, depend on the financial sector to channel money from savers (typically consumers) toinvestment projects around the economy If a crisis paralyzes the banking system, it is very difficultfor an economy to resume normal economic activity Ben Bernanke famously advanced bank collapse

as an important reason that the Great Depression of the 1930s lasted so long and hit so hard Sofinancial crises, particularly those that are large and difficult to resolve, can have profound effects.Again, as in the case of multiple equilibria and financial fragility, there is a large economic theoryliterature on the topic.6 This strong connection between financial markets and real economic activity,particularly when financial markets cease to function, is what has made so many of the crises weconsider in this book such spectacular historic events Consider, in contrast, the collapse of the techstock bubble in 2001 Although technology stocks soared and collapsed, the effect on the realeconomy was only the relatively mild recession of 2001 Bubbles are far more dangerous when theyare fueled by debt, as in the case of the global housing price explosion of the early 2000s

Surely, the Second Great Contraction—as we term the financial crisis of the late 2000s, whichhas spread to nearly every region—will have a profound effect on economics, particularly the study

of linkages between financial markets and the real economy.7 We hope some of the facts laid out inthis book will be helpful in framing the problems that the new theories need to explain, not just for therecent crisis but for the multitude of crises that have occurred in the past, not to mention the many thathave yet to unfold

THIS TIME IS

DIFFERENT

1

-VARIETIES OF CRISES AND THEIR DATES

Because this book is grounded in a quantitative and historical analysis of crises, it is important tobegin by defining exactly what constitutes a financial crisis, as well as the methods—quantitativewhere possible—by which we date its beginning and end This chapter and the two that follow layout the basic concepts, definitions, methodology, and approach toward data collection and analysisthat underpin our study of the historical international experience with almost any kind of economiccrisis, be it a sovereign debt default, banking, inflation, or exchange rate crisis

Delving into precise definitions of a crisis in an initial chapter rather than simply including them

in a glossary may seem somewhat tedious But for the reader to properly interpret the sweepinghistorical figures and tables that follow later in this volume, it is essential to have a sense of how wedelineate what constitutes a crisis and what does not The boundaries we draw are generallyconsistent with the existing empirical economics literature, which by and large is segmented acrossthe various types of crises we consider (e.g., sovereign debt, exchange rate) We try to highlight anycases in which results are conspicuously sensitive to small changes in our cutoff points or where weare particularly concerned about clear inadequacies in the data This definition chapter also gives us

a convenient opportunity to expand a bit more on the variety of crises we take up in this book

The reader should note that the crisis markers discussed in this chapter refer to the measurement

of crises within individual countries Later on, we discuss a number of ways to think about theinternational dimensions of crises and their intensity and transmission, culminating in our definition of

a global crisis in chapter 16 In addition to reporting on one country at a time, our root measures ofcrisis thresholds report on only one type of crisis at a time (e.g., exchange rate crashes, inflation,banking crises) As we emphasize, particularly in chapter 16, different varieties of crises tend to fall

in clusters, suggesting that it may be possible, in principle, to have systemic definitions of crises Butfor a number of reasons, we prefer to focus on the simplest and most transparent delineation of crisisepisodes, especially because doing otherwise would make it very difficult to make broadcomparisons across countries and time These definitions of crises are rooted in the existingempirical literature and referenced accordingly

We begin by discussing crises that can readily be given strict quantitative definitions, then turn tothose for which we must rely on more qualitative and judgmental analysis The concluding section

defines serial default and the this-time-is-different syndrome, concepts that will recur throughout the

remainder of the book

Crises Defined by Quantitative Thresholds:

Inflation, Currency Crashes, and Debasement

Inflation Crises

We begin by defining inflation crises, both because of their universality and long historicalsignificance and because of the relative simplicity and clarity with which they can be identified.Because we are interested in cataloging the extent of default (through inflating debt away) and notonly its frequency, we will attempt to mark not only the beginning of an inflation or currency crisisepisode but its duration as well Many high-inflation spells can best be described as chronic—lastingmany years, sometimes dissipating and sometimes plateauing at an intermediate level beforeexploding A number of studies, including our own earlier work on classifying post–World War IIexchange rate arrangements, use a twelve-month inflation threshold of 40 percent or higher as themark of a high-inflation episode Of course, one can argue that the effects of inflation are pernicious

at much lower levels of inflation, say 10 percent, but the costs of sustained moderate inflation are notwell established either theoretically or empirically In our earlier work on the post–World War IIera, we chose a 40 percent cutoff because there is a fairly broad consensus that such levels arepernicious; we discuss general inflation trends and lower peaks where significant Hyperinflations—

inflation rates of 40 percent per month—are of modern vintage As we will see in chapter 12 oninflation crises (especially in table 12.3), Hungary in 1946 (Zimbabwe’s recent experiencenotwithstanding) holds the record in our sample

For the pre–World War I period, however, even 40 percent per annum is too high an inflation

threshold, because inflation rates were much lower then, especially before the advent of modernpaper currency (often referred to as “fiat” currency because it has no intrinsic value and is worthsomething only because the government declares by fiat that other currencies are not legal tender indomestic transactions) The median inflation rates before World War I were well below those of themore recent period: 0.5 percent per annum for 1500–1799 and 0.71 percent for 1800–1913, incontrast with 5.0 percent for 1914–2006 In periods with much lower average inflation rates and littleexpectation of high inflation, much lower inflation rates could be quite shocking and traumatic to aneconomy—and therefore considered crises.1 Thus, in this book, in order to meaningfully incorporateearlier periods, we adopt an inflation crisis threshold of 20 percent per annum At most of the mainpoints at which we believe there were inflation crises, our main assertions appear to be reasonablyrobust relative to our choice of threshold; for example, our assertion that there was a crisis at anygiven point would stand up had we defined inflation crises using a lower threshold of, say, 15percent, or a higher threshold of, say, 25 percent Of course, given that we are making most of ourdata set available online, readers are free to set their own threshold for inflation or for otherquantitative crisis benchmarks

Currency Crashes

In order to date currency crashes, we follow a variant of an approach introduced by Jeffrey Frankeland Andrew Rose, who focus exclusively on large exchange rate depreciations and set their basicthreshold (subject to some caveats) as 25 percent per annum.2 This definition is the mostparsimonious, for it does not rely on other variables such as reserve losses (data governments oftenguard jealously—sometimes long delaying their publication) and interest rate hikes (which are notterribly meaningful in financial systems under very heavy government control, which was in fact thecase for most countries until relatively recently) As with inflation, the 25 percent threshold that onemight apply to data from the period after World War II—at least to define a severe exchange ratecrisis—would be too high for the earlier period, when much smaller movements constituted huge

surprises and were therefore extremely disruptive Therefore, we define as a currency crash anannual depreciation in excess of 15 percent Mirroring our treatment of inflation episodes, we areconcerned here not only with the dating of the initial crash (as in Frankel and Rose as well asKaminsky and Reinhart) but with the full period in which annual depreciations exceeded thethreshold.3 It is hardly surprising that the largest crashes shown in table 1.1 are similar in timing andorder of magnitude to the profile for inflation crises The “honor” of the record currency crash,however, goes not to Hungary (as in the case of inflation) but to Greece in 1944.

Currency Debasement

The precursor of modern inflation and foreign exchange rate crises was currency debasement duringthe long era in which the principal means of exchange was metallic coins Not surprisingly,debasements were particularly frequent and large during wars, when drastic reductions in the silvercontent of the currency sometimes provided sovereigns with their most important source of financing

In this book we also date currency “reforms” or conversions and their magnitudes Suchconversions form a part of every hyperinflation episode in our sample; indeed it is not unusual to seethat there were several conversions in quick succession For example, in its struggle withhyperinflation, Brazil had no fewer than four currency conversions from 1986 to 1994 When webegan to work on this book, in terms of the magnitude of a single conversion, the record holder wasChina, which in 1948 had a conversion rate of three million to one Alas, by the time of itscompletion, that record was surpassed by Zimbabwe with a ten-billion-to-one conversion!Conversions also follow spells of high (but not necessarily hyper) inflation, and these cases are alsoincluded in our list of modern debasements

TABLE 1.1

Defining crises: A summary of quantitative thresholds

The Bursting of Asset Price Bubbles

The same quantitative methodology could be applied in dating the bursting of asset price bubbles(equity or real estate), which are commonplace in the run-up to banking crises We discuss thesecrash episodes involving equity prices in chapter 16 and leave real estate crises for future research.4One reason we do not tackle the issue here is that price data for many key assets underlying financialcrises, particularly housing prices, are extremely difficult to come by on a long-term cross-countrybasis However, our data set does include housing prices for a number of both developed andemerging market countries over the past couple of decades, which we shall exploit later in ouranalysis of banking crises

Crises Defined by Events: Banking Crises and External and Domestic Default

In this section we describe the criteria used in this study to date banking crises, external debt crises,

and domestic debt crisis counterparts, the last of which are by far the least well documented andunderstood Box 1.1 provides a brief glossary to the key concepts of debt used throughout ouranalysis.

Banking Crises

With regard to banking crises, our analysis stresses events The main reason we use this approach has

to do with the lack of long-range time series data that would allow us to date banking or financialcrises quantitatively along the lines of inflation or currency crashes For example, the relative price

of bank stocks (or financial institutions relative to the market) would be a logical indicator toexamine However, doing this is problematic, particularly for the earlier part of our sample and fordeveloping countries, where many domestic banks do not have publicly traded equity

Another idea would be to use changes in bank deposits to date crises In cases in which thebeginning of a banking crisis has been marked by bank runs and withdrawals, this indicator wouldwork well, for example in dating the numerous banking panics of the 1800s Often, however, bankingproblems arise not from the liability side but from a protracted deterioration in asset quality, be itfrom a collapse in real estate prices (as in the United States at the outset of the 2007 subprimefinancial crisis) or from increased bankruptcies in the nonfinancial sector (as in later stages of thefinancial crisis of the late 2000s) In this case, a large increase in bankruptcies or nonperformingloans could be used to mark the onset of the crisis Unfortunately, indicators of business failures andnonperforming loans are usually available sporadically, if at all, even for the modern period in manycountries In any event, reports of nonperforming loans are often wildly inaccurate, for banks try tohide their problems for as long as possible and supervisory agencies often look the other way

BOX 1.1

Debt glossary

External debt The total debt liabilities of a country with foreign creditors, both official (public) and private Creditors often

determine all the terms of the debt contracts, which are normally subject to the jurisdiction of the foreign creditors or to international law (for multilateral credits).

Total government debt (total public debt) The total debt liabilities of a government with both domestic and foreign creditors.

The “government” normally comprises the central administration, provincial governments, federal governments, and all other entities that borrow with an explicit government guarantee.

Government domestic debt All debt liabilities of a government that are issued under and subject to national jurisdiction, regardless

of the nationality of the creditor or the currency denomination of the debt; therefore, it includes government foreign-currency domestic debt, as defined below The terms of the debt contracts can be determined by the market or set unilaterally by the government.

Government foreign-currency domestic debt Debt liabilities of a government issued under national jurisdiction that are

nonetheless expressed in (or linked to) a currency different from the national currency of the country.

Central bank debt Not usually included under government debt, despite the fact that it usually carries an implicit government

guarantee Central banks usually issue such debt to facilitate open market operations (including sterilized intervention) Such debts may be denominated in either local or foreign currency.

Given these data limitations, we mark a banking crisis by two types of events: (1) bank runs thatlead to the closure, merging, or takeover by the public sector of one or more financial institutions (as

in Venezuela in 1993 or Argentina in 2001) and (2) if there are no runs, the closure, merging,takeover, or large-scale government assistance of an important financial institution (or group ofinstitutions) that marks the start of a string of similar outcomes for other financial institutions (as inThailand from 1996 to 1997) We rely on existing studies of banking crises and on the financial press.Financial stress is almost invariably extremely great during these periods.

There are several main sources for cross-country dating of crises For the period after 1970, thecomprehensive and well-known studies by Caprio and Klingebiel—the most updated version ofwhich covers the period through 2003—are authoritative, especially in terms of classifying bankingcrises into systemic versus more benign categories Kaminsky and Reinhart, and Jácome (the latter forLatin America), round out the sources.5 In addition, we draw on many country-specific studies thatpick up episodes of banking crisis not covered by the multicountry literature; these country-specificstudies make an important contribution to this chronology.6 A summary discussion of the limitations ofthis event-based dating approach is presented in table 1.2 The years in which the banking crisesbegan are listed in appendixes A.3 and A.4 (for most early episodes it is difficult to ascertain exactlyhow long the crisis lasted)

External Debt Crises

External debt crises involve outright default on a government’s external debt obligations—that is, adefault on a payment to creditors of a loan issued under another country’s jurisdiction, typically (butnot always) denominated in a foreign currency, and typically held mostly by foreign creditors.Argentina holds the record for the largest default; in 2001 it defaulted on more than $95 billion inexternal debt In the case of Argentina, the default was managed by reducing and stretching outinterest payments Sometimes countries repudiate the debt outright, as in the case of Mexico in 1867,when more than $100 million worth of peso debt issued by Emperor Maximilian was repudiated bythe Juarez government More typically, though, the government restructures debt on terms lessfavorable to the lender than were those in the original contract (for instance, India’s little-knownexternal restructurings in 1958–1972)

TABLE 1.2

Defining crises by events: A summary

External defaults have received considerable attention in the academic literature from leadingmodern-day economic historians, such as Michael Bordo, Barry Eichengreen, Marc Flandreau, PeterLindert, John Morton, and Alan Taylor.7 Relative to early banking crises (not to mention domesticdebt crises, which have been all but ignored in the literature), much is known about the causes andconsequences of these rather dramatic episodes The dates of sovereign defaults and restructuringsare those listed and discussed in chapter 6 For the period after 1824, the majority of dates come fromseveral Standard and Poor’s studies listed in the data appendixes However, these are incomplete,missing numerous postwar restructurings and early defaults, so this source has been supplementedwith additional information.8

Although external default dates are, by and large, clearly defined and far less contentious than,say, the dates of banking crises (for which the end is often unclear), some judgment calls are stillrequired, as we discuss in chapter 8 For example, in cataloging the number of times a country hasdefaulted, we generally categorize any default that occurs two years or less after a previous default aspart of the same episode Finding the end date for sovereign external defaults, although easier than inthe case of banking crises (because a formal agreement with creditors often marks the termination),still presents a number of issues

Although the time of default is accurately classified as a crisis year, in a large number of casesthe final resolution with the creditors (if it ever was achieved) seems interminable Russia’s 1918default following the revolution holds the record, lasting sixty-nine years Greece’s default in 1826shut it out of international capital markets for fifty-three consecutive years, and Honduras’s 1873default had a comparable duration.9 Of course, looking at the full default episode is useful forcharacterizing borrowing or default cycles, calculating “hazard” rates, and so on But it is hardlycredible that a spell of fifty-three years could be considered a crisis—even if those years were notexactly prosperous Thus, in addition to constructing the country-specific dummy variables to coverthe entire episode, we have employed two other qualitative variables aimed at encompassing the corecrisis period surrounding the default The first of these records only the year of default as a crisis,while the second creates a seven-year window centered on the default date The rationale is thatneither the three years that precede a default nor the three years that follow it can be considered a

“normal” or “tranquil” period This technique allows analysis of the behavior of various economicand financial indicators around the crisis on a consistent basis over time and across countries

Domestic Debt Crises

Domestic public debt is issued under a country’s own legal jurisdiction In most countries, over most

of their history, domestic debt has been denominated in the local currency and held mainly byresidents By the same token, the overwhelming majority of external public debt—debt under the legaljurisdiction of foreign governments—has been denominated in foreign currency and held by foreignresidents

Information on domestic debt crises is scarce, but not because these crises do not take place.Indeed, as we illustrate in chapter 9, domestic debt crises typically occur against a backdrop of muchworse economic conditions than the average external default Usually, however, domestic debt crises

do not involve powerful external creditors Perhaps this may help explain why so many episodes gounnoticed in the mainstream business and financial press and why studies of such crises areunderrepresented in the academic literature Of course, this is not always the case Mexico’s much-publicized near-default in 1994–1995 certainly qualifies as a “famous” domestic default crisis,although not many observers may realize that the bulk of the problem debt was technically domestic

and not external In fact, the government debt (in the form of tesobonos, mostly short-term debt

instruments repayable in pesos linked to the U.S dollar), which was on the verge of default until thecountry was bailed out by the International Monetary Fund and the U.S Treasury, was issued underdomestic Mexican law and therefore was part of Mexico’s domestic debt One can only speculate that

if the tesobonos had not been so widely held by nonresidents, perhaps this crisis would have

received far less attention Since 1980, Argentina has defaulted three times on its domestic debt Thetwo domestic debt defaults that coincided with defaults on external debt (1982 and 2001) attractedconsiderable international attention However, the large-scale 1989 default that did not involve a newdefault on external debt—and therefore did not involve nonresidents—is scarcely known in theliterature The many defaults on domestic debt that occurred during the Great Depression of the 1930s

in both advanced economies and developing ones are not terribly well documented Even wheredomestic defaults are documented in official volumes on debt, it is often only footnotes that refer toarrears or suspensions of payments

Finally, some of the domestic defaults that involved the forcible conversion of foreign currency